The Abusive Trust Tax Arrangement Explained

The Abusive Trust Tax Arrangement Explained

Abusive Trust Tax Arrangement

One of the most confusing aspects of US tax law involves the tax treatment of trusts. The reason why trust tax law is so complicated is that there are many different types of trusts that can be used for many different types of purposes. For example, it is not uncommon for US persons in the United States to have a revocable trust which becomes irrevocable at death. Retirement plans are another type of trust in which there is an Owner (company), Trustee (administrator), and Beneficiary (employee). Depending on whether the retirement trust is qualified or not (most foreign pension plans are not qualified) will impact the tax liability. It gets even more complicated, depending on whether or not it is a grantor trust or non-grantor trust; whether or not the beneficiary contributed or settled any assets into the trust — and whether or not it is a simple or complex trust. But, no matter how you slice it — the Internal Revenue Service is always skeptical of trusts — because they are often designed to avoid or defer tax.

What is an Abusive Trust Tax Arrangement?

the IRS publishes a summary of the different abusive trust tax evasion schemes to be aware of. Unfortunately, many US persons get swept up by promoters into abusive trust schemes which are illegal and may result in significant taxes, fines, and penalties. Let’s take a look at what the Internal Revenue Service has to say about abusive trust tax evasion schemes:

As provided by the IRS:

Abusive Trust Tax Evasion Schemes – Facts (Section I)


“Substantial wealth is transferred from one generation to the next, much of which is transferred using variety of trusts. Although the vast majority of these transfers are legitimate, there is widespread potential for fraud.

In the last few years, the Internal Revenue Service has detected a proliferation of abusive trust tax evasion schemes. These promotions are targeted towards wealthy individuals, small business owners, and professionals such as doctors and lawyers.

Abusive trust arrangements typically are promoted by the promise of such benefits as:

      • Reduction or elimination of income subject to tax.

      • Deductions for personal expenses paid by the trust.

      • Depreciation deductions of an owner’s personal expenses paid by the trust.

      • Depreciation deductions of an owner’s personal residence and furnishings.

      • A stepped-up basis for property transferred to the trust.

      • The reduction or elimination of self-employment taxes.

      • The reduction or elimination of gift and estate taxes.

Abusive trust arrangements often use trusts to hide the true ownership of assets and income or to disguise the substance of transactions. Although these schemes give the appearance of separating responsibility and control from the benefits of ownership, as would be the case with legitimate trusts, the taxpayer in fact controls them.

These arrangements frequently involve more than one trust, each holding different assets of the taxpayer (the taxpayer’s business, equipment, home, automobile, etc.), as well as interests in other trusts. The trusts are vertically layered, with each trust distributing income to the next layer. Funds may flow from one trust to another trust by way of rental agreements, fees for services, purchase and sale agreements, and distributions. The goal is to use inflated or nonexistent deductions to reduce taxable income to nominal amounts.

Although the individual abusive promotions vary, two basic schemes have been identified:

      • The domestic package, and

      • The foreign package.

These schemes are often promoted by a network of promoters and sub-promoters who have charged $5,000 to $70,000 for their packages. This fee enables taxpayers to have trust documents prepared, to utilize foreign and domestic trustees as offered by promoters, and to use foreign bank accounts and corporations. In some instances, tax return preparer services are also made available.

Taxpayers should be aware that abusive trust arrangements will not produce the tax benefits advertised by their promoters and that the IRS is actively examining these types of trust arrangements. Furthermore, in appropriate circumstances, taxpayers and/or the promoters of these trust arrangements may be subject to civil and/or criminal penalties.”

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